Failing to Disclose a Lack of Control

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Whenever I think of oil and gas syndications, I think of Dallas and J.R. Ewing. You can get screwed over in the wiggle of one of Larry Hagman’s luxurious eyebrows. The SEC’s complaint against Infinity Exploration for securities fraud in connection with oil and gas wells still caught my attention.

The first question is whether the interests would be securities or real estate. The SEC complaint focused on two offerings: Matagorda and New Mexico 10. Both were pooled investment vehicles. Infinity will have to battle its own statement. The PPMs for the investments both state that the offering consists of “securities” and that the investments are being offered pursuant to Regulation D.

One of the main charges is that Infinity mischaracterized what the pooled investment vehicles owned. The PPMs stated that the investment objective was to acquire, own, and deal with the prospect and that Infinity would perform drilling, testing and operations of the well. The SEC charges that Infinity was merely raising funds to invest in a joint venture with another firm and that Infinity would not be in a control position. The PPMs never disclosed that investors were purchasing an interest in an entity that would merely hold interests in another joint venture. The SEC also lays out a long list of other false or misleading statements in the PPMs.

Assuming the SEC view is correct, the lesson is to properly disclose the nature of the investments when fund raising. Real estate often has several layers of ownership and control. The key is to properly disclose those layers and how your investment fits into the mix.

The second big failure is that Infinity mischaracterized the use of proceeds. The PPM said that 80% would go to pay well-related costs, and the balance to administrative and overhead costs. The SEC charges that the 80% went to the third party joint venture partner who was actually doing the well work and Infinity kept the 20% as a commission.

It all fell apart when the joint venture partner went belly up. One investor had put in $37,500 with promises of immediate income and return of 100% of principal within a year. He ended up with a grand total of $667 in revenue. That is less than the annual grooming cost was for the late Larry Hagman’s eyebrows.

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